Appraisers decry the devaluation of 409A work

BVWireIssue #94-1
July 14, 2010

We received a flurry of responses to the item on 409A valuations in the most recent BVWire™ (“CFOs don’t value appraisals done for 409A compliance”). Not surprisingly, they all warned against the many risks of valuing cost over quality work:

  • “409A valuations are not ‘in danger of becoming commoditized to the lowest cost providers,’" writes Jeffrey Tarbell (Houlihan Lokey). “That happened years ago. Until we see a few high profile cases in which companies or CFO's get penalized by the IRS—and we might soon—CFO's will continue to direct this business to largely unqualified ‘chop shops.’ The fees those firms charge indicate either: (1) they pay their staff in peanuts, or (2) they don't put any meaningful time into the analysis.”
  • “It is ironic that the 409A rule was part of the American Jobs Creation Act—yet most of the work is done overseas,” writes Shiva Badruswamy (AccuServe U.S., Inc.), who’s covered the topic on his blog. Most valuators, vendors—and CFOs—do not realize that 409A engagements must satisfy an evidentiary requirement, he says. To help change this perception, appraisers “can only keep educating clients about the uselessness of doing valuations that don't meet basic U.S. evidentiary standards.”
  • Client resistance may remain high (and prices low) so long as 409A regulations continue to provide a safe harbor to early-stage companies that don't foresee a liquidity event and hire an otherwise "qualified" appraiser, explains James B. Lurie (CapVal-American Business Appraisers, LLC). The only offset: Auditors still want high-quality work on 123R engagements, which typically derive from 409A values. “If FASB ever gets its head on straight and recognizes that stock option grants do not generate an economic expense at the enterprise level, this [123R] pressure will evaporate,” Lurie predicts, and the prices on 409A work may dip even further.

And what about the effect of private secondary sales? “With the attractiveness and increasing popularity of marketplaces for pre-IPO stock . . . , there is growing debate over how transactions in private company stock impact the value of company securities for 409A purposes,” writes Bo Brustkern (Arcstone Partners) in a recent article for PEHub. “[A]n argument could be made that the prices achieved in secondary market transactions are not reliable indicators of fair market value for 409A purposes. However, each transaction is executed under different circumstances, so no broad-based rule of thumb may reasonably be applied.”  Precisely: 409A valuations depend on numerous variables; for a complete overview how to apply 409A to early-stage companies and more, check out BVR’s Guide to Valuations for IRC 409A Compliance, by Neil Beaton.

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